David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Huaming Power Equipment Co.,Ltd (SZSE:002270) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Huaming Power EquipmentLtd Carry?

As you can see below, Huaming Power EquipmentLtd had CN¥350.7m of debt at June 2024, down from CN¥378.3m a year prior. But on the other hand it also has CN¥1.08b in cash, leading to a CN¥733.8m net cash position.

How Strong Is Huaming Power EquipmentLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Huaming Power EquipmentLtd had liabilities of CN¥655.8m due within 12 months and liabilities of CN¥481.6m due beyond that. Offsetting these obligations, it had cash of CN¥1.08b as well as receivables valued at CN¥1.24b due within 12 months. So it can boast CN¥1.19b more liquid assets than total liabilities.

This surplus suggests that Huaming Power EquipmentLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Huaming Power EquipmentLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Huaming Power EquipmentLtd grew its EBIT by 19% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Huaming Power EquipmentLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Huaming Power EquipmentLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Huaming Power EquipmentLtd generated free cash flow amounting to a very robust 100% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Huaming Power EquipmentLtd has net cash of CN¥733.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in CN¥571m. So we don't think Huaming Power EquipmentLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Huaming Power EquipmentLtd .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.